Fitch, one of the world’s largest credit rating agencies, recently warned that the rapid spread of the mpox virus in sub-Saharan Africa could add to the fiscal pressures many countries in the region are already experiencing.
The Africa Centres for Disease Control and Prevention and the World Health Organization have declared the recent outbreak of mpox in Africa a public health emergency. An epidemic in the Democratic Republic of Congo has spread to neighbouring countries.
Seven countries rated by Fitch — Cameroon, Côte d’Ivoire, Kenya, Nigeria, Rwanda, South Africa and Uganda — have confirmed mpox cases.
Fitch cautioned investors about possible underreporting of mpox cases and that the outbreak could accelerate, raising the prospect of increased pressure on government finances.
But is this alarm call necessary? Or is it exaggerated?
Based on my research into rating agencies over the past 10 years, there are clear biases in the way they assess African sovereign risk. Fitch’s statement can be seen as another case of a rating agency looking at events in Africa through a more negative prism than the one it uses for countries in the West.
Several studies have found evidence of bias, with rating agencies overstating certain risk factors on the continent.
A comparative analysis of 30 countries in Africa and other regions shows a lack of uniformity in the application of the economic indicators in ratings. This was behind the African Union’s decision to adopt a declaration on the establishment of an African Credit Rating Agency.
However, some rating analysts have come to the defence of rating agencies, arguing that there is no bias against African countries.
For their part, rating agencies maintain that their methodologies are objective. And a recent article in Reuters claims that there were no studies showing evidence of statistical bias in ratings against Africa.
In my view, these claims raise the question: what measure is being used to assess bias? This is important because bias can manifest in different ways — through decisions about what to measure (quantitative) or through more subtle forms of qualitative bias.
I argue in this article that credit ratings are subjectively biased against Africa. And that one of the key contributing factors is the location of the rating analysts.
A thin presence
Most rating analysts are based in Europe, Asia, and the US. Of the big three, Standard & Poor’s and Moody’s each have a single office in South Africa. They have a total of five to 10 analysts covering about 25 sovereigns, corporates and sub-sovereigns. Fitch Ratings closed its only Africa office in 2015.
This raises questions about analysts’ workloads and the accuracy of their ratings.
Ratings analysts based abroad visit the countries they rate for a maximum of two weeks in a year.
This is insufficient time for analysts to adequately understand and evaluate risk factors. Inadequate consultation and short visits have led analysts to base their assessments on pessimistic assumptions, desktop reviews, virtual discussions and publicly available information.
These processes have also omitted critical data, which is often best obtained by being on the ground in a country. Estimates of subjective risk factors in policy effectiveness, quality of institutions, political and geopolitical dynamics. Analysts’ conservatism, lack of contextual understanding and rating errors have been a recurring feature of African ratings.
Research shows that familiarity with a country, proximity to a rated country and home bias (towards the home country of a rating analyst) lead analysts to assign better sovereign ratings than for countries they are unfamiliar with or live very far away from.
Where there’s room for bias
To understand how bias can occur, it’s important to break down the credit rating methodology.
For example, S&P Global’s sovereign rating methodology looks at five key factors. Two are primarily quantitative – economic and monetary. The other three are essentially qualitative – institutional, external and fiscal.
For the qualitative factors, rating agencies use a score of 1 to 6. Rating analysts have considerable discretion in assigning qualitative judgments to the scores. Judgments could easily be influenced by bias.
Credit rating researchers Patrycja Klusak, Yurtsev Uymaz and Rasha Alsakka have found that a connection between a European finance minister and a top executive at one of the three international rating agencies can favourably bias a rating decision.
A relationship between a finance minister and a director, executive or senior analyst at a rating agency could raise a sovereign’s rating by between 0.5 and 1.3 notches.
African rating errors
Here are some examples of errors made by credit rating agencies in their assessment of African countries.
Tunisia: Fitch made an error in a December 2022 review of Tunisia. Fitch published its rating of Tunisia outside the scheduled calendar, without taking into account all available and relevant information. Fitch corrected this three months later, but only to comply with the European Securities Markets Authority’s regulatory requirement for rating agencies not to deviate from the calendar for the publication of sovereign ratings. In my view, this error could have been avoided if Fitch had had a local presence in the country.
Cameroon: In affirming Cameroon’s Caa1 rating, Moody’s took issue with the government’s decision to grant a 5 per cent salary increase to civil servants and other public sector workers as negative. Cameroon also suspended a proposed additional personal income tax, which Moody’s interpreted as a negative development for the country’s credit profile. But Cameroon fiscal metrics were moderate. The country could afford the wage increase. Markets viewed its fiscal budget as modest compared to peers with similar population profiles.
Moreover, the rating agencies had incorrect ratings for Cameroon from November 2022 to August 2023. Their ratings were based on unverified information about late external debt service payments between January and November 2022. The rating agencies’ actions a year later and the reports on Cameroon’s late debt service payments suggest that the agencies did not have timely and factual official information. Had the agencies been sufficiently engaged with relevant government officials, their analysts would have had such information.
Nigeria: Moody’s reversed its downgrade of Nigeria’s outlook within seven months. As the reason for changing its mind, it cited positive economic policy developments, including the government’s removal of fuel subsidies and the country’s unified exchange rate. But these economic factors had not changed between the downgrade and its reversal. The Nigerian government had challenged Moody’s initial decision, arguing that the rating agency didn’t understand the country’s domestic environment.
The reversal of Nigeria’s rating direction in the short term could be evidence that the rating agency had erred in its initial analysis.
The way forward
Placing more analysts on the continent and expanding the scope and duration of consultations will address some of the biases in how rating agencies rate African countries. Where analysts are already based in Africa, they need to broaden the scope of their stakeholder consultations and to spend more time in the countries they rate.
The interpretation of events and risk perceptions of locally based analysts will be different from those of expatriate analysts. This will partly address contestation around the bias and lack of adequate consultation in Africa ratings.
Misheck Mutize, Post Doctoral Researcher, Graduate School of Business (GSB), University of Cape Town
This article is republished from The Conversation under a Creative Commons licence. Read the original article.
